Chapter Nineteen

Acquisitions and Mergers in Financial Services Management

Key Topics
Merger Trends in the United States and Abroad Motives for Merger Selecting a Suitable Merger Partner U.S. and European Merger Rules Making a Merger Successful Research on Merger Motives and Outcomes

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Motives Behind the Rapid Growth in Bank Mergers

Forces of Consolidation and Convergence: Since 1980 more than 10,000 mergers among US-insured depository institutions. Why?

Profit Potential Risk Reduction Rescue of Failing Banks Tax and MarketPositioning Motives Cost-Savings or Efficiency Motive
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Mergers as a Device for Reducing Mergers as a Device for Maximizing Competition Managements Welfare Other Motives

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Some Recent Acquisitions in the Credit Crisis of 2007

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Merger Motives Identified By Bank Executives and Employees

Quality of Management Profitability (Return on Assets) Efficiency of Operations Maintenance of Market Share

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Quick Quiz
What is consolidation? Convergence? Why are there so many mergers each year in the financial-services industries? What factors seem to motivate most mergers?

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Selecting a Suitable Merger Partner

The Most Important Goal of Any Merger Should Be to Increase the Market Value of the Surviving Firm.
Market price per share of stock

t 1

E(D t ) (1 c) t

Where annual expected dividends per share are represented by E(Dt) and c is the opportunity cost of capital
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How Can The Maximization Goal be Achieved?

Improve Operating Efficiency (reduce operating cost per unit of output) Geographic Diversification Product Line Diversification
Consolidate Operations and Eliminate Duplication

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Impact on Earnings Per Share

Generally Speaking Shareholders of Both the Acquired and Acquiring Firm Will Gain If: 1. Bank with Higher P/E Ratio Acquires Bank with Lower P/E Ratio And If: 2. Combined Earnings Do Not Fall After the Merger

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Merger Premium
As Long as the Acquiring Institutions P-E Ratio is Larger Than the Acquired Firms P-E Ratio, There is Room for Paying Merger Premium.

A Merger Premium is Paid if the Acquiring Banks Shareholders Receive More Than the Current Market Price for Their Stock
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Exchange Ratio

The Number of Shares of Stock Offered By an Acquiring Bank for Each Share of Stock of the Acquired Bank

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Dilution of Ownership
Dilution of Ownership Occurs When the Acquiring Bank Offers an Excessive Number of Shares to the Acquired Bank Shareholders. The EPS Will Fall Below its Original Level for the Acquiring Bank When This Happens.

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Principal Factors of Target Firm to Consider

The Banks History, Ownership and Management The Condition of Its Balance Sheet The Firms Track Record of Growth and Operating Performance The Condition of Income Statement The Condition and Prospects of the Local Economy Competitive Structure of the Market Area
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Other Characteristics of the Target Firm to Examine

The Comparative Management Styles of the Merging Organizations The Principal Customers the Targeted Bank Serves Current Personnel and Employee Benefits Compatibility of Accounting and Management Information Systems of the Merging Organizations Condition of the Banks Physical Assets Ownership and Earnings Dilution Before and After the Proposed Merger
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Purchase of Assets Method of Purchasing Another Bank

A Method of Carrying Out a Merger in Which the Buying Company Purchases All of the Assets of the Acquired Firm Using Either Cash or its Own Stock

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Purchase of Stock Method of Purchasing Another Bank

A Method of Consummating a Merger in Which the Acquired Firm Ceases to Exist; The Acquiring Firm Assumes all of its assets and Liabilities; Exchanges its Equity Shares for the Stock of the Acquirer

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Regulatory Rules for Bank Mergers in the US: Bank Merger Act, 1960

First Major U.S. Law to Bring Merging Banks Under Federal Supervision, Requiring Government Approval to Merge with or Acquire Other Banks

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Under the Bank Merger Act

Merger Must Be Approved By Principal Regulator

Regulatory Agency Must Give Top Priority to Competitive Effects Mergers with Anti-Competitive Effects May Be Approved if it Can Be Shown That There Are Significant Public Benefits Such As Providing Convenient Services or Rescuing a Failing Bank McGraw-Hill/Irwin
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National Banks Comptroller of the Currency State Member Banks Federal Reserve State Insured Banks FDIC

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Herfindahl-Hirschman Index (HHI)

Measure of Market Concentration It is the Sum of the Squared Market Share for All Banks in a Specific Market Area Department of Justice (DOJ) Guidelines Postmerger HHI Below 1000, then the market is unconcentrated, no further action; Moderately Concentrated Market (HHI between 1000-1800) and change in HHI<100, no further action Possible challenges if HHI increases by more than 200 points to a level of 1800 or more

See the St. Louis Fed Cassidi website: http://cassidi.stlouisfed.org

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Keys to Merger Success

Acquirer Must Start By Evaluating Its Own Financial Condition Must Have Detailed Analysis of Possible New Markets Must Establish a Realistic Price for Target Firm Afterwards Combined Team Must Direct Progress Towards Consolidation Must Establish Communication Between Senior Management and All Employees Must Create Communication Channels for Customers and Employees to Understand Why Merger Took Place Should Create Customer Advisory Panels to Evaluate and Comment on Merged Banks Image and Products
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Quick Quiz
What factors should a financial firm consider when choosing a good merger partner? What factors must the regulatory authorities consider when deciding whether to approve or deny a merger? When is a market too concentrated to allow a merger to proceed? Does it appear that most mergers serve the public interest?
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